It's Just Money

Why is a Buyer's Agent paid on a percentage of the sale price?

Here's something that has always bothered me.  In a typical real estate transaction, you have a seller and a buyer, each represented by a real estate agent.  The role of the seller's agent is clear.  Advertise/publicize the availability of the house for sale, find a qualified buyer, sell the house for the highest price and most favorable terms possible.  The seller's agent is paid a percentage of the sales price, which aligns their interest with the seller.

The writers of Freakonomics will disagree here.  They are of the position that due to the size of the percentage, seller's agents primary interests are the timliness and completion of the sale rather than the final price.  In other words, in the case of a $500,000 house that receives an offer for $490,000, the seller's agent would likely be happy to see this sale go through.  If the agent's makes 3% of the sale price, their commission would drop to $14,700 from $15,000 for not getting the full sale price.  The seller, on the other hand, "loses" $10,000.  Thus, speed of sale may be a higher priority for the agent than the seller.  Granted, not always the case.  Sometimes a highly motivated seller values the timliness of the sale above price as well.

Anyway, this isn't my point.  I'm talking about buyer's agents.

A buyer's agent is responsible for helping the buyer find a house that suits their needs and desires.  They assist them in the negotiation process, helping the buyer to achieve the best terms and lowest price possible.  So, why is the buyer's agent paid a percentage of the sales price?

Just as with the seller's agent, the buyer's agent has as their top priority the completion of the sale.  However, in the case of the buyer's agent, if they fail at their duty to negotiate the best price possible for their client, they make MORE money!  That's insane!

I suppose I can understand a higher commission for a higher end property.  I suppose.  Although, not really.  Is it really three times more difficult to help a buyer looking for a $400,000 house, as a $1,200,000 house?  At any rate, I think a fee negotiated at the beginning would make a heck of a lot more sense.

Maybe I'm missing something.  Am I off base?

D.R. Horton CEO: "2007 is going to suck"

On the one hand you have to applaud the straight talk from the CEO of the largest home builder in the world.  On the other hand, do you appreciate his use of the word suck?  Here's the full quote:  "I don't want to be too sophisticated here, but '07 is going to suck, all 12 months of the calendar year,"

He believes that builders will regain pricing power in 2008, but not before they try to unload the existing glut of houses on the market.

It's a little odd isn't it?  It appears that his use of the word was planned.  He set it up, used a little irony.  Yet it's a crude word.  Juvenile even.  Even still, it may have conveyed his message more clearly and succinctly than any other way he could have put it. 

He could have put it in corporate speak, "we anticipate continued negative price growth, as excess production and multiple entrants into the market has created a temporary situation of declining pricing power.  We do not anticipate that we will regain said pricing power until 2008."

Or, "07 is going to suck."

Frankly, I prefer the latter.

Out of State Real Estate Investing

I love the idea of investing in real estate, but the recent price appreciation of the last few years has made Los Angeles, and Southern California in general, both price prohibitive and common sense prohibitive.  Take for example the fourplex that I wrote about a month and a half ago.  It sat there in a prime Los Angeles location with a $1,249,000 asking price, and a gross rent multiplier of 20.2, given the rents of $5,150.  I just checked with Zillow, and it turns out that they sold near the end of January for $1,180,000.  A virtual bargain at that price.  The proud new owner is looking at a GRM of 19.09.  They'll have to put down more than a quarter of the purchase price to break even on monthly cash flow!

So, that being said, I have been thinking about investing in real estate out of California.  The way I see it, there are two benefits.  Of course, there are drawbacks that come with it.

Interesting stats from the California Association of Realtors

The California Association of Realtors (CAR) has released their 2006 State of the Housing Market Report.  Much of it reads like old news.  "sales are down," "affordability is low," "price appreciation slows."  I feel like I have been reading this online and in the papers since last summer.  But this is a report on the 2006 summary, and comparing the numbers to 2005 and years prior.  At the bottom they provide a litany of numbers that I thought was fascinating.

Some of the most interesting stats were:

• The proportion of first-time buyers who purchased a single-family home increased slightly from 61 percent in 2005 to 65 percent in 2006, but still remained significantly below the 72 percent recorded in 2004.
• The median down payment declined 8.8 percent from $80,000 in 2005 to $73,000 in 2006, despite an increase in the median home price. This was the first time since 1995 that the median down payment dropped.
• The median down payment for first-time buyers decreased from $25,000 in 2005 to $10,000 in 2006, while the median down payment for repeat buyers decreased from $119,000 to $100,000.
• The median loan amount for first mortgages continued to increase in 2006 along with rising home prices, climbing 8.2 percent from $384,000 to $415,500 among all buyers.
• The median first mortgage amount for first-time buyers increased 6.8 percent from $347,800 to $371,600, while the median first mortgage amount for repeat buyers increased 8.1 percent from $400,000 to $432,500.
• The typical first-time buyer had a median age of 35, earned an annual household income of $80,000, and purchased a home with a historically high median price of $450,000.
• The typical repeat buyer had a median age of 45, earned an annual household income of $120,000, and purchased a home with a historically high median price of $618,000.

Let me break down those numbers into more real life type of examples.

Why Are Condo Prices More Vulnerable in a Downturn?

Housing bubble or not, there is little debate that we are in a slow period for real estate sales.  Is it a buyer's market?  That's what the mainstream media tells us.  But mostly they are reporting what the National Association of Realtors and their local counterparts are feeding them.  Inventory is up, Days on Market is up, but prices have mostly remained stable, or continued to rise slightly in most areas.  For those areas that have seen actual price declines, the hardest hit are generally the condos.  Most familiar with real estate will acknowledge this to be a common occurrence.

For example, take a look at the December 2006 numbers reported in the Los Angeles Times.  LA county saw prices continue to rise on a year over year basis.  But single family residences saw a greater increase.  SFR median prices were up 5.8%, while the median condo sale price was 3.0% higher.  In Orange County, things were even slower.  SFR median prices barely edged to the positive, up 0.8% versus condo prices which sold at a median 4.3% below a year prior.  The biggest declines in median prices have been in Ventura County and San Diego County, where house prices dropped 1.6% and 1.8% respectively.  However, median condo prices in those two counties declined 2.8% and 2.6% respectively.

So, I'm wondering why condo prices tend to be more vulnerable in a downturn than single family residences.  I have some theories, but I would love to hear any thoughts that you might have.  Here are my theories.

I just hope it's not real

Being the glutton for irrational debate that I am, every once in a while I cruise over to the Craig's List housing forums.  Most of the content consists of participants anonymously posting links or observations to affirm their strongly held belief of a bursting housing bubble, or a rising housing market.  On rare occasion, participants will start a thread seeking advice, such as the quality of certain neighborhoods, or landlord/tennant issues.  Today, I came across a post that I believe to be a fake.  Well, I hope so anyway.  The post is written to the Los Angeles board, but available for all to read:

Okay, here's the deal: my wife and I have combined yearly income of $140,000, but we've always had a heavy expense load and only have around $10,000 in savings and maybe another $20,000 in an IRA. We figure buying a house will do two things: help us financially prepare for the future by building equity, and also force us to be a little more thrifty on our spending.

Why is the housing market such a polarizing, emotional debate?

This is weird to me.  Two relatively intelligent people can discuss anything related to economics and disagree while rationally stating their points.  They may disagree on tax laws, whether we are heading towards inflation or deflation, whether they are bullish or bearish on the stock market, what action the Fed will take, or any other economic issue.  But not the housing market.  When it comes to the housing market individuals tend to become absolutists.  They "know" that the market will collapse into oblivion, or they "know" that prices will always go up.  And those are the ones who don't get emotional.  The emotional ones quickly reduce to hurling personal insults.

I began to notice this in the comments of my post, My Unbelievable Conversation with a Realtor.  This is my most often clicked post currently featured on Interest.com.  The increased traffic has led to a more diverse group reading this post; a group not familiar with my writings as some of my more frequent readers.

Fourplex For Sale... I don't get it.

I'm totally serious.  Maybe I'm showing my inexperience here, but I don't get why someone would buy this.

For sale is a four unit building in a desireable part of Los Angeles.  Check out the listing on Realtor.com.  Looks to be in good condition.  All four units are currently rented.  I called the realtor and found out that three of the four units are within their one year leases.  The fourth is currently month to month.  They have tennants sign one year leases, then let them go month to month after that.  So, this means that the tennants are paying current market rate.  In other words, the rents are not artificially low due to a two decade tennant in a rent controlled area.

The total monthly rents are $5150.  Not a bad investment property.

The problem, of course, is the asking price.  They want $1,249,000.  Plain ol' gross rent multiplier calculations tell us to look out.  GRM=price/annual rents.  As I understand it, you are looking for a GRM of around ten or less.  In this case $1,249,000/$61,800 = 20.2.  Yikes, red flags already.

But that's just an estimate.  How you finance it matters, but let's keep it simple and say that you put down 20% (~$250k) and finance the rest at around 6.5% in a 30 year fixed.  Your monthly mortgage payment would be $6,320.  Now I understand that there are tax savings and depreciation and such.  But after you pay for insurance, property taxes and maintenance, that's still a pretty huge negative cash flow.  Not to mention the opportunity cost of the $250k downpayment.  Stick that in a CD and you'll make about a grand a month.

Is it for appreciation?  Let's say you finance with an interest only for five years.  If you put the same $250k down and got a 6% interest only rate, your monthly payment would be $5k even.  After taxes, insurance and opportunity cost, you are cash flow negative.  But what if you could float by on that for the next five years.  Could you sell it for $1.5 mil and make a nice quarter million in a few years?  Or more?  But I guess I would have to ask why the next guy would pay that much.  Unless the rents increased significantly.

I don't know.  Is there someone out there with experience with this type of property?  Could you explain why you would buy it, and how you would make a profit?  Thanks.

Is this what they mean by "closing the barn doors after the cows are gone?"

On Yahoo Real Estate News this morning, I find this headline, "Alarmed By Rising Defaults, NAR Educates Consumers About Exotic and Subprime Loans."

Shouldn't that education have happened when before thousands (or millions?) of people borrowed more money than they could afford?

Or is the expression, "too little, too late"?

Flip This/That House! And Flip it NOW!

In my earlier series, Flippers in Trouble, I spotlighted apparent house flippers who had clearly gotten in over their heads.  The purpose was to remind readers of the risks involved in flipping houses, despite the promises of late night TV.  That and a bit of schadenfreud.  My methodology was always a bit haphazard.  I looked for houses with price reductions and lengthy time on market.  I cross checked the property on Zillow for the last sale date and price, which of course is the current owner.  If the price paid was close to, or above, the current asking price, we had a flipper in trouble.  Factor in the renovation/remodeling costs, carrying costs, realtor fees, and most of these flippers were probably in deeper than it appeared.

I found another flipper, but I'm not prepared to call him a flipper in trouble.  See despite all this schadenfreud (which always reminds me of the old Smith's song, "We Hate It When Our Friends Become Successful"), I realize that flipping houses provides a tremendous opportunity for profit.  However, rapid price appreciation made these profits all too easy.  We all know what happens when there are easy profits.  It attracts lesser and lesser talents.

So, let's talk about this current flipper.